Should we abolish the minimum wage?

Research suggests that companies raise prices rather than reduce staff

It is ten years since the national minimum wage was introduced as one of New Labour's most radical and controversial economic policies. Hailed as a great triumph for social justice, it was the culmination of decades of arguing and lobbying amid vehement opposition. Business leaders and the political right claimed it would be bad for the economy, while unions feared that it would undermine collective bargaining and drag down pay rates above it.

However, when its effects proved relatively benign, it soon became broadly accepted by all the mainstream parties, trade unions and most business organisations, and has been widely credited with improving the living standards of the lowest paid, and helping to close the gap between men and women's pay.

The Low Pay Commission estimated that workers in 1.3 million jobs, some five per cent of all jobs, were entitled to higher wages as a result of the introduction of the national minimum wage of £3.60 an hour for adults in 1999. The adult rate increased by seven pence to £5.80 in October 2009.

With the UK now in recession, critics are warning that rates, which are increased annually, have risen faster than prices or earnings, and that the minimum wage is now threatening jobs and penalising small businesses. How employers have managed to offset the cost of the minimum wage is, therefore, a crucial question that has been explored by Jonathan Wadsworth at LSE's Centre for Economic Performance.

In a discussion paper, Did the National Minimum Wage Affect UK prices ?,Dr Wadsworth sets out to discover whether firms who employ minimum wage workers could have passed on any higher labour costs resulting from the minimum wage in the form of higher prices.

He does this by comparing prices of goods produced by industries that employ a substantial number of minimum wage workers with those companies which do not.

He found that, initially, there was little in the way of significant price rises, but that, over time, prices in several minimum wage sectors – notably take-away foods, canteen meals, hotel services and domestic services – do appear to have risen significantly faster than the prices of non-minimum wage sectors. These effects were particularly significant in the four years immediately after the introduction of the minimum wage.

He used the Labour Force Survey and the Annual Survey of Hours and Earnings to identify minimum wage goods and services. He then matched this to retail prices. Dr Wadsworth found that the prices of several minimum wage sectors, notably domestic services, hotel services, canteen meals and take-away food all rose by a significantly greater rate – in the order of 0.5 to 2 percentage points a year – than the prices of other goods in the period after the minimum wage was introduced.

He discovered that firms do not raise their prices in the month of any minimum wage upgrade – with the possible exception of April 1999 when the minimum was introduced and the magnitude of the wage cost shock was higher than in any subsequent upgrade. Also, firms do not appear to change prices when the new level of the minimum wage is announced six months prior to its introduction. Instead, any effects on prices appear to accumulate gradually over time.

Earlier this year, the Conservative MP, Christopher Chope, backed by ten colleagues, introduced a private member's bill which would have allowed people to opt out of the minimum wage. This was later withdrawn amid fierce opposition, but it prompted fears that it was a "kite-flying" exercise to test public opinion and that a future Conservative government could introduce similar legislation.

Dr Wadsworth commented: "The research adds to a growing body of evidence in the UK suggesting that the simple notion that higher minimum wages mean job losses need not hold. It seems that some firms can, and do, adjust by raising prices, just as other work shows that they can seek to boost productivity or adjust profits."

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